An extremist, not a fanatic

March 09, 2012

How a mansion tax helps the rich

Supporters of a mansion tax seem to have overlooked something - that such a tax would not be a tax upon the rich so much as upon the older rich.

I say this for a simple reason. The price of any asset should be equal to the discounted present value of the net benefits from it. Because a tax reduces the net benefits of a mansion, prices of them should thus fall. In other words, the tax should get capitalized into prices.

History suggests this is just what happens. Some research (pdf) at the IFS found that the replacement of rates by the poll tax in 1989 - the abolition of a tax on housing - caused a big rise in house prices. In inner London, an anticipated saving of £471 per year on rates added almost £6000 to the price of an average house (in 1985 prices).

That was not by any means full capitalization; the capitalization rate was only around one-third. But there are two good reasons why the capitalization rate might be higher for a mansion tax:

- In the late 80s there were doubts as to whether the shift from rates to poll tax would persist, given the unpopularity of the latter; such doubts were of course wholly correct. The risk of a reversion to property taxes would have dampened the boost to house prices. Because there’s more chance of the mansion tax persisting - especially if it gets cross-party support - it should be more fully capitalized.

- There’s more substitutability for mansions than for housing generally. A £1.9m house is a decent substitute for a £2m-plus one, whereas there are fewer close substitutes for home ownership generally. This means that potential buyers of mansions have the bargaining power to bid their prices down.

Insofar as the mansion tax is capitalized, it is present owners of them who lose two-fold; they have to pay the tax, but also see the value of their asset depreciate.

But house prices are not net wealth. A falling price of mansions is a benefit for those who would like to buy them. If the tax were 100% capitalized, the effect upon future buyers would be zero. Yes, they’d face a tax on their purchase, but they’d also pay a lower price for the Mansion. The two would net out.

And who are future buyers of mansions? They are the younger, slightly less rich - those who might well already own houses in the £1-2 million bracket. Indeed, some of these could even benefit from such a tax. This would happen if the price of their desired house falls to just below £2m, or if prospective buyers shift from £2m to sub-£2m-priced houses, thus bidding up the price of the latter.

Now, I don’t think all this is a clinching argument against a mansion tax. I favour it, insofar as it is a slippery slope towards a fuller, more intelligent, land value tax. But let’s not kid ourselves that a Mansion tax is hitting the rich. Some of the rich might even gain from it.

Comments

One thing we can predict with some confidence is that the eye-catching £2m cliff-edge will result in a profitable new line of tax avoidance.

Post-implementation, the high-end property market will probably see a clustering of houses at £1.999m, and a dearth between £2.0m and perhaps £2.2m. The latter figure will depend on how effective the means of transferring disguised payments will be.

"£1.9m for the house and £0.3m for the lampshades", will perhaps be a not uncommon bid.

Given the substitutability higher up the housing ladder, surely if your analysis holds true it simply means that there would be a sort of "trickle-down" pressure on house prices across the spectrum?

If people can expect to be able to get a mansion for £1.9million as house prices at the top get squeezed down, it diminishes the relative value of houses £200-300k below that and so-on, finally putting downward pressure on the ever spiralling property market. Part of the problem we've had in recent years is house prices rising well above inflation. Anything that dampens down property speculation and reduces the levels of debt people are interested in taking on to pay for it can surely only be a good thing.

The house valuation for council tax bands is based on the open market rate (i.e. presumed sale price) as of 1991 in England and 2003 in Wales.

They didn't rate each house individually, but used average rates from estate agents for streets/areas, with a "drive by" check for variations from the mean. This crude method has led to many thousands of appeals and subsequent rebandings.

Handling the mansion tax in the same way will be problematic. The mansion threshold will be set quite high to only capture a minority. This means some properties will be anomalies in their area. Initial individual valuations will be both practical and necessary.

To avoid property inflation leading to mid-level houses being sucked into the tax (a PR disaster for any government), I'd expect upgrading the threshold (and thus revaluation) to be more frequent than council tax revaluation, where the benefits of doing nothing have outweighed action.

It is possible that a property that fell just short of the threshold in one year would qualify in a subsequent year due to above-average appreciation in its area, however I suspect the government would fight shy of imposing a tax solely on a notional valuation. The easiest (most defensible) method would be to revalue on sale using the actual price.

The sheer panicked effort being put in by opponents of the mansion tax is its best recommendation. Every desperate argument that it will be unworkable, prone to avoidance is so much hooey.

So there'll be a threshold effect, big deal - as if we don't already see that with stamp duty. And, yes, you could avoid that with a drive-by evaluation by experienced valuers, subject to a fair & transparent appeals process. And the problem with that is..?

These people's problem with it is that it will work as intended - not avoidable and successfully raising money from the criminally undertaxed super-rich to help fund the inevitable costs of running a civilised country. And that is unacceptable: paying taxes is for the little people.

Meanwhile, our host's argument doesn't run either. It's precisely the older rich who have made all this unearned wealth from rising land values. Time for them to give back, a little.

@ Carl, Bill etc - yes, values would be based on "drive-by" valuations, but I don't see how this affects my analysis.
@ Woodstockjag - I'm not sure there would be such a trickle-down,except insofar as sellers of mansions trading down have less purchasing power - but these are surely only a fraction of the buyers of sub-£2m houses.
Think of it this way: if a tax were levied on BMWs but not Mercs, wouldn't the price of Mercs rise as potential BMW buyers switched?
@ Strategist - I'm not complaining at all that the older rich would pay. I think they should. My point is that this is not the impost upon all the rich that some people think.

What rate is proposed for this mansion tax? 1% over £2m is mentioned in one article I've read, or would it be 1% of the entire value, if over £2m?

Assuming its the latter, that would amount to £20K+ pa. Now thats a fair chunk, but if you earn £1m/year you're going to save 10% of your income as the 50% rate is going. Which would be roughly speaking £100K.

So in fact, if you're sitting in a £2.5m house, you'd have to be earning less than about £400k to lose out.

So as far as I can see this mansion tax is a gold mine for the super rich (those with incomes over £500K), and a hefty tax on people who are indeed wealthy by any definition, but not exactly Bill Gates or Roman Abramovitch. Or even the CEO of a mid ranking FTSE 100 company.

The sort of people who will lose out will be people in mid management roles in big companies, or CEOs of small ones, or successful small to mid sized business owners.

It certainly isn't going to affect your Bob Diamonds and your Goldman Sachs types, which is who I think those proposing it are assuming it will clobber.

Chris, BMW and Mercs are differentiated horizontally, but vertically of the same quality; whereas 2m mansions are higher quality then sub 2m properties. Therefore, those that before the tax could have only bought a sub2m property, after the tax will either pay less for their previous target or prefer to buy a property of higher quality now at the same price. Hence, the trickle down effect. You have to keep together the fact that perspective buyers will shift towards sub2m properties to avoid the tax with the fact that mansions previously priced just above the tresholds will move into that bracket, hence crowding out previous sub2m ones.

The problem I have with the mansion tax is the idea of yet another tax adding to the 2.5 million words in Tolley's Tax Guide. What we should be doing is making tax less taxing (ouch).

How much will a mansion tax raise compared to the 550 billion the government takes off use already? How much will it cost to implement? Wouldn't it just be a lot easier if the government addressed the deficit by spending less?

The real value of a mansion tax is not the deflationary effect it will have on the housing market, nor the revenue raised immediately for the exchequer, but where the wealth will be stored instead if it is not stored in property. It would most likely either go into banks (who need the deposits in this age of deleveraging) or preferably into investments. Property, unless we are talking about farming or commercial landlords, is not a particularly productive asset and it would be more beneficial to society to try and curb this form of wealth storage in favour of something that will generate jobs and other economic activity (which in turn can be taxed).

"That was not by any means full capitalization; the capitalization rate was only around one-third."

I don't follow you there. £471 capitalises to £6,000 at nearly 8%. Are you suggesting it should be 24%? I can't see how a libility of £471 p.a. could reduced the property value by £18,000. With the kind of investment returns that are available today, even 8% seems steep.